Outlook

Supply pressures to ease further in 2019.

Going into 2019, supply risk will lend support to REITs across most real estate sectors. We expect supply pressures to ease in the industrial sector as we have gone past the peak in supply in 2018.

For the retail sector, supply is expected to peak in 2019 with the opening of Jewel Changi, but c.90% of space has already been pre-committed. Thus, supply should no longer be a major concern for investors going forward.

The office and hotel sectors will continue to see modest new additions, which lend support to landlords raising rents.

Still healthy demand translating into rising rents.

Based on our DBS economist forecast, the Singapore economy is projected to grow by 3.0% in 2019, down from 3.4% in 2018. On the back of this healthy economic backdrop and muted supply, we expect office rents to rise 5-10% and hotel revenue per available room (RevPAR) by 3-4%.

Meanwhile, industrial rents should increase by 3% with retail rents bottoming after falling over the last few years.

DPU to accelerate in 2019-2020.

On the back of an improvement in spot rents and impact from over S$8bn worth of acquisitions made in 2018, we expect the S- REITs to deliver steady c.2% DPU growth in 2019 and increasing by a further c.2.6% thereafter.

Near term, we expect the retail/ commercial sectors to deliver the fastest growth owing to the impact of inorganic growth from CMT’s recent acquisitions and reopening of its Funan mall and MCT’s benefitting from recent AEI’s.

Meanwhile, positive rental reversions achieved in the office sector over 2H18 should start to filter through to a recovery in DPU growth in 2019 for most office REITs.

Besides the recovery in spot rents, the industrial sector should continue to maintain its track record of steady DPU growth largely due to acquisition made in the previous year.

Finally, following a disappointing 2018, the hospitality REITs should benefit from an overall uplift in the Singapore hospitality market but at a more modest rate.

Overseas push to continue.

With tight asset yields in Singapore, we expect REITs to continue to pursue overseas acquisitions. In our view, the move overseas is most pressing for some industrial REITs given their exposure to properties with another 30-40 years remaining on their land tenure.

Impact of higher interest rates to filter through.

While S-REITs on average have maintained hedges on 70- 80% of its borrowings on fixed rates, as interest rate hedges start to roll off and various S-REITs refinance their borrowings in 2019, we will start to see a greater impact on borrowing costs after the increase in benchmark interest rates over the last two years.

Nevertheless, this should be mitigated by the ability to grow income on the back of higher spot rents.

Risks

Faster pace of interest rate increases.

While the US Federal Reserve is expected to raise interest rates by 2- 3 times next year, an even faster pace of interest rate hikes, would present downside risk to our DPU estimates and valuations. A 1% increase in borrowing costs, on average would result in 2-3% decrease in DPU estimates.

In addition, there is 4-8% impact on our DCF valuations if we were to use a 4% Singapore risk free rate rather than 3% currently.

While we expect demand to continue to remain healthy leading to a recovery in rents, the ongoing trade war poses downside risk to our occupancy and rental assumptions.

Valuation & Stock Picks

Attractive yields and steady growth in DPU underpin positive outlook.

We expect the S-REIT sector to increase at a steady pace over the coming year given the tightening real estate conditions, positive news flow in the form of rising spot rents and increasing rental reversions as well as prospects of faster DPU growth in 2019.

While S-REITs currently trade at a forward FY19/20F yield of c.6.3% with a yield spread of c.3.8% which is in line with the historical average yield. The high absolute yield in our view remains attractive given the prevailing macro uncertainty.

Overweight retail and industrial REITs owing to macro uncertainty.

While we expect the S-REITs to deliver growth in DPU going forward, we expect investors to gravitate towards the retail and industrial sectors in 2019, owing to heightened risk surrounding demand for office space and hotel rooms arising from the ongoing trade war and risk of near-recession conditions in the US in 4Q20.

Both the retail and industrial sectors have less downside risk to earnings given their exposure to non-discretionary suburban retail spend and longer WALEs in comparison to office and hotel REITs. Furthermore, the industrial REITs, due their higher absolute yields, provide a better buffer to the impact of rising interest rates.

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